With mainstream markets in trouble, infrastructure looks like the place to be for many investors. Let’s look at the bigger picture. Can infrastructure investments deliver what they promise? And as traditional infrastructure is changing fast, how can investors adapt? The short answer is: Looking forward, many new opportunities are emerging, but managing infrastructure assets will become more challenging, more costly, and perhaps even more political than in the past.
Infrastructure investing has seen a remarkable development since its “invention” in the 1990s in Australia. The volume of unlisted/private infrastructure investments has kept growing to a volume of over US$ 1000bn globally. What have we learnt over the last 20 years?
In terms of performance, investors have, so far, been reasonably happy overall. Surveys show that returns have been – broadly speaking – within or above expectations. However, experiences can be very mixed and – at times – rather volatile.
Investors noted that infrastructure assets are very diverse, and they learnt to look deeper not only into their funds but also the underlying companies and projects. Infrastructure is not a homogeneous asset class where you can apply simple actuarial risk-return parameters. A thorough bottom-up approach is required: What can specific assets do for your portfolio?
Another important journey has been finding appropriate investment vehicles. Initially, the industry was somewhat wrong-footed with a limited choice of private equity-type funds. Fortunately, the choice of investment instruments has expanded considerably over the years.
The most remarkable development, however, has the been the success of the “Canadian model”. Larger asset owners increasingly undertake direct investing in private assets, aiming for better control and lower costs. For smaller plans, co-investment alongside managers and co-investment platforms of different shapes have been established.
Infrastructure investing faces several challenges. The immediate problem is the new, less benign macro-environment. Analysts these days are busy with working out the sensitivity of different assets to higher inflation, interest rates and recession scenarios. Somewhat surprisingly, academic research has been slow to investigate such important questions.
The second challenge is finding the right infrastructure projects. What we can observe, is a clear shift of emphasis in transactions. Initially, the main sectors targeted were in large-scale economic infrastructure such as airports or utility networks. In recent years, renewable energy has risen to over 50% of infrastructure deals. Consequently, many investors’ infrastructure portfolios have become “greener”, but also quite concentrated on wind and solar.
A third issue is the continuously changing definitions of infrastructure. You find your surprises in funds. People will always have different views of what is “essential for society” or what “predictable cash flows” are. What is the answer? What we can ask for is transparency about what people consider infrastructure, and the reasons why they want to invest in.
Mega-trends such as urbanization and digitization will continue to shape infrastructure investing, with “digital infrastructure” assets such as fibre networks, satellite towers and data centers en vogue. There is an increasing quest also for more “sustainable infrastructure”. This should not be too difficult, given infrastructure’s natural connotation with green objectives (e.g. public transport, clean water) or social objectives (e.g. health, education). Covid-19 brought a renewed focus on “social infrastructure”.
Climate investing, decarbonization, net-zero investing is moving high on the agenda of infrastructure investors. So, managers will have to go further than the mainstream renewable assets. “Energy transition” assets are in high demand, whether they be in hydrogen, energy transmission, batteries, grid stabilization, carbon capture & storage, EV stations, etc. More capital will be needed for “climate adaptation”. There is also not enough focus yet on energy efficiency and security, or on upgrading existing transport and energy system to become more climate resilient. All this will require strong political leadership.
This leads us to the final point: politics as major challenge. Governments all over the world come out with grandiose new infrastructure plans and institutions to “unlock” institutional assets. However, politicians often fail to come up with consistent policies, clear project pipelines and credible funding models.
Investors increasingly realize that infrastructure investments are inherently political, whether they are regulated utilities, public-private partnerships, or contracted with local authorities. Government subsidies, guarantees, availability payments can be both an opportunity and a risk.
To go one step further: the rise of “infrastructure nationalism”. Somewhat unnoticed, over the last decade, more and more countries have started to protect “strategic” or “critical” industries from foreigners, including transport, energy and high tech. This is for rising national security concerns or the protection of national interests.
To sum it up, after 20 years, the “first mover advantage” is over for infrastructure. One important implication is the growing importance of ongoing good asset management that requires adequate resources – it comes at a cost. Infrastructure investments have a high economic, social and environmental impact. The public will insist on visible service improvements – even more so from private owners and operators of public infrastructure. Therefore, institutional investors’ credibility is crucial. We will hear more about their “social license” to operate.
The full article is available at “Institutional Investing in Infrastructure” (i3), July 2023.